Potential Rule 10b-5 Liability for Misleading Statements and Omissions

In March 2019, the Supreme Court issued its decision in Lorenzo v. SEC, 139 S. Ct. 1094 (2019), in which the Court held that those who disseminate false or misleading statements with the intent to defraud—even if they are not the “maker” of the statement—can be found to have violated subsections (a) and (c) of Rule 10b-5 of the federal securities laws, often referred to as the “scheme liability” subsections of Rule 10b-5. In the wake of Lorenzo, we and other commentators cautioned that Lorenzo could be seen as expanding potential liability for third-party actors and non-speakers who were thought to be outside the ambit Rule 10b-5 under earlier Supreme Court decisions which held that there was no aiding and abetting liability under Rule 10b-5 (Central Bank) and that only the “maker” of a statement can be liable for violations of subsection (b) of Rule 10b-5 (Janus).

It has not taken long for these concerns to materialize. In a recent decision by the Tenth Circuit, Malouf v. SEC, 933 F.3d 1248 (10th Cir. 2019), the Court—citing Lorenzo—found that an individual who was neither the “maker” nor the “disseminator” of an allegedly misleading statement and accompanying omission could nonetheless still be held liable for the challenged omission. Such a result was hardly imaginable prior to Lorenzo, and even after Lorenzo, it represents a surprising expansion of the potential reach of misrepresentations and omissions liability under Rule 10b-5.

Background

Following the Supreme Court’s decision in Janus, which famously held that only the “maker” of a statement can be liable for violations of Rule 10b-5(b), the Court granted certiorari in Lorenzo v. SEC to decide whether a defendant who is not the “maker” of a statement under Rule 10b-5(b) could nevertheless be held liable under the other subsections of Rule 10b-5, namely subsections (a) and (c), when the only conduct involved concerns a misstatement or a corresponding omission.

In Lorenzo, the defendant, an investment banker at a broker-dealer and investment banking firm, sent an email to two potential investors concerning one of the firm’s clients. The email falsely touted the safety of the potential investment and included a statement that the subject company had $10 million in assets, which the defendant knew to be inaccurate. The email was drafted by, and sent at the request of, the defendant’s boss.

The question before the Court was whether someone who is not a “maker” of a misstatement or corresponding omission under Janus can nevertheless be found to have violated the scheme liability subsections of Rule 10b-5 in respect of a misstatement or omission.

In the majority decision, the Court reasoned that the language of subsections (a) and (c) of Rule 10b-5 (i.e., the scheme liability sections) were broad enough to include within their scope the dissemination of false or misleading information with an intent to defraud. The Court found that, by sending emails he knew to contain materially false statements, the defendant “employ[ed]” a “device,” “scheme,” and “artifice to defraud” within the meaning of subsection (a) of the Rule, and that through the same conduct, he also “engage[ed] in a[n] act, practice, or course of business” that “operate[d]…as a fraud or deceit” under subsection (c) of the Rule.

The defendant argued that subsections (a) and (c) of Rule 10b-5 involve “scheme liability claims” that are only violated when conduct other than misstatements or omissions is involved and that, where misstatements or omissions are at issue, only those who “make” misstatements under subsection (b) can violate Rule 10b-5. Therefore, according to the defendant, Janus precluded liability under Rule10b-5 because he was not the “maker” of the misstatement, as he did not personally draft it.

The Court disagreed, describing Rule 10b-5 as “include[ing] both a general proscription against fraudulent and deceptive practices and, out of an abundance of caution, a specific proscription against nondisclosure.” The Court found it “difficult to see how [the defendant’s] actions could escape the reach of those provisions,” given that scienter was undisputed. The Court, however, recognized that applying subsections (a) and (c) of Rule 10b-5 to the dissemination of alleged misstatements “may present difficult problems of scope in borderline cases,” such as where the individual is only “tangentially involved in dissemination.”

The Tenth Circuit’s Decision in Malouf

After the Lorenzo decision, we and many other commentators expressed concern that Lorenzo injected uncertainty into the marketplace and could be viewed as an invitation to plaintiffs to bring broader claims against non-“makers” that many previously thought Janus (and Central Bank) had closed the door to.

On August 13, 2019, the Tenth Circuit became the first circuit court to apply the Lorenzo decision. In Malouf v. SEC, the Court cited Lorenzo in holding that an employee was primarily liable under subsections (a) and (c) of Rule 10b-5 for knowingly failing to correct misstatements and omissions in its employer’s SEC filings and on its website.

Similar to Lorenzo, the facts of Malouf did not paint the defendant in a sympathetic light, and scienter was easily inferred. Dennis Malouf occupied two roles at two firms: a securities broker-dealer at Raymond James Financial In Malouf v. SEC, the Court cited Lorenzo in holding that an employee was primarily liable under subsections (a) and (c) of Rule 10b-5 for knowingly failing to correct misstatements and omissions in its employer’s SEC filings and on its website.

Similar to Lorenzo, the facts of Malouf did not paint the defendant in a sympathetic light, and scienter was easily inferred. Dennis Malouf occupied two roles at two firms: a securities broker-dealer at Raymond James Financial Services, and an investment adviser at UASNM, Inc. When Raymond James became aware of Malouf’s role at UASNM, Raymond James asked Malouf to choose between the roles. Malouf then opted to sell his Raymond James branch for $1.1 million, which was to be paid
in installments based on the Raymond James branch’s collection of securities-related fees. Malouf then “perpetuated” the conflict by routing bond trades on behalf of UASNM clients through the Raymond James branch to ensure that the buyer of the Raymond James branch would receive enough in commissions to make the installment payments. In doing so, Malouf did not disclose this conflict to UASNM clients despite that UASNM had been making ongoing representations to UASNM clients that no UASNM employees were receiving any commissions from the Raymond James Branch, and that UASNM was providing impartial advice to clients. In addition to this routing of the bond trades, Malouf also acknowledged that he regularly did not seek competing bids, which he admitted would have led to better prices for his clients.

Against this backdrop, the Tenth Circuit agreed with the SEC that Malouf “bore the responsibility” for UASNM’s SEC filings and ensuring that its website was accurate and that Malouf knowingly took “no steps to remedy” UASNM’s misstatements. The Court held that Malouf’s inaction in correcting the misstatements made by UASNM ultimately triggered his liability under subsections (a) and (c) of Rule 10b-5 as being part and parcel of a “fraudulent or deceptive scheme.” In support of its holding, the Tenth Circuit noted that Lorenzo “expressly held that a person could incur liability under [Rule 10b-5] provisions when the conduct involves another person’s false or misleading statement.”

Taking a step back to look at the larger picture, while Malouf might not have been a good actor, there is no dispute that he was neither the “maker” of the alleged misstatements or omissions under Janus, nor a “disseminator” of those misstatements or omissions under any reading of Lorenzo (a proposition not squarely addressed by the Tenth Circuit in Malouf). Given that under the sum total of Janus and Lorenzo, either “maker” or “disseminator” status was required for misstatements or omissions liability under the totality of Rule 10b-5’s three sub-sections, how was Malouf found liable by the Tenth Circuit?

Unfortunately, it appears that the Tenth Circuit in Malouf might have taken the Lorenzo decision too far by reading into it a license to employ a results-driven application of the law to find securities liability in respect of misstatements or omissions where a defendant—who indisputably acts with an intent to defraud (e.g., scienter)—is at the scene of an alleged misstatements or omissions case, even where that defendant is neither the maker or disseminator of the challenged misstatement or omissions.

Conclusion

If there was any uncertainty as to how expansive a net Lorenzo would cast on potential defendants in misrepresentation or omissions cases, Malouf suggests that it might be a wide one. The Malouf decision may not only capture just individuals who pressed the “send” button on an email drafted by (and which purports to be speaking for) another person as was the case in Lorenzo, but also those who could be described as passive participants with respect to misleading statements and omissions made by others.

Although the Tenth Circuit’s Malouf decision holds significance as the first circuit court decision to apply Lorenzo, other circuit courts will surely have an opportunity to consider what constitutes actionable dissemination under Lorenzo. Hence, we might be looking at several years of district and circuit courts working out diverging views on the subject. Ultimately, it is likely that litigants will not obtain sufficient clarity on these issues until the Supreme Court weighs in and resolves the uncertainty its Lorenzo decision engendered.